Commercial Banks The two ACID TEST functions of

Commercial Banks

The two ACID TEST functions of commercial banks are : 1. Accepting deposits 2. Lending or advancing loans

Functions of Commercial Banks

PRIMARY OR BASIC FUNCTIONS AGENCY FUNCTIONS OR SERVICES GENERAL UTILITY SERVICES OR FUNCTIONS

Primary or basic functions 1. Accepting Deposits 2. Lending or Advancing loans 3. Credit Creation 4. Cheque System of payment of funds.

Accepting deposits The first major function of commercial bank is acceptance of deposits from the public. Although a bank accepts non-chequable deposits also , it must accept the chequable deposits from the public. It is these deposits i. e. deposits withdrawable by cheque.

Lending or advancing loans • • • Money at call Overdraft Cash credit Discounting of bills Term loans Credit to government(s).

Credit creation • This function is automatically performed while advancing loans or credit or deposits. Banks are able to create credit because the demand deposits i. e. a claim against the bank is accepted by public in settlement of their debts

Cheque system of payment of funds • A negotiable instrument which in fact is a bill of exchange drawn upon a banker, is the most popular credit instrument used by client to make payments

Agency functions or services:

1. Collection and payment of credit 2. Sale and purchase of stock exchange securities 3. Administration of wills and trusteeship 4. Remittance of funds 5. Bullion trading

General utility services or functions

1. Receiving of valuables for safe custody 1. Acting as a referee 2. Issuing letters of credit 3. Acting as underwriters and brokers 4. Acting as information banks 5. Issuing of traveler’s cheques and credit cards 1. Issuing of gift cheques 2. Dealing in foreign exchanges 3. Merchant banking services

Resultative functions: 1. Mobilisation of savings of the people 2. Channelising savings into productive channels 3. Extension of financial services to rural areas 4. Making credit to weaker sections of society

Commercial Banks and Economic Development • • Helpful in mobilisation of saving. Assists in Innovation. Role in implementation of monetory policy. Bank influence the interest rate. Helpful in the development of Priority sectors. Directing funds into desired channels. Helpful in productive activities and exports. Implementation of the policies of the government.

CREDIT CREATION • Meaning of Credit Creation ? Credit creation refers to the power of commercial banks to expand secondary deposits either through the process of making loans or through investment in securities. This is one of the important function of commercial banks. Credit creation in two forms : - 1. Primary Deposits 2. Derivative Deposits banks play an active role in the creation of money.

Advantages of Credit Creation Ø Price Stability. Ø Economic Stability. Ø Maximisation of Employment. Ø Economic Growth. Ø Stabilisation of Money Market. Ø Exchange Rate Stability.

Process of Credit Creation Money is supplied in the form of Demand Deposits and DD of commmercial Banks are many times more than there Cash Reserve. Example: - Cash Reserve = Rs. 1, 000 and Demand Deposit = Rs. 10, 000 The question arises how CRR of 1, 000 is converted into DD of Rs. 10, 000. It can be explained as follows: 1. By way of their historical experience that all the depositiers would not show up in the bank all the withdrawls. 2. If bank experiences show that withdrawal are normally 10% of the deposits then bank only keeps 10% of deposits as cash reserve. 3. Cash reserve of Rs. 1, 000 is converted into DD of Rs. 10, 000 by following way : Demand Deposit = 1/CRR * Cash Reserve = 1/10% * 1000 = 10, 000 Maximum Loan = Rs. 10, 000 4. Commercial Bank gives loan in form of Demand Deposits only.

Limitations of Credit Creation • • • Amount of cash. Banking habits. Cash reserve ratio. Policy of other bank. External cash drain. Market situation. Availability of good securities. Monetary policy of central bank. Availability of good borrowers.